January 2017

January 27, 2017

In the previous entry, I discussed the real-world distributional effects of trade agreements, in the specific case of NAFTA. Why should we care about such redistribution and how should we deal with it?

It is useful to distinguish between two different versions of an argument as to why trade may be problematic from a social or political perspective.

Trade is problematic because it redistributes income.

Trade is problematic because it violates norms and understandings embodied in our institutional arrangements – it undercuts domestic social bargains.

The first case is no different than a million other things in a market economy that can have distributional implications. It does not in general require that we target trade specifically.

But the second case is different, and may require trade remedies. I associate the valid core of fair-trade or social-dumping concerns with this particular possibility.

Economists like to claim that the purpose of free trade is to eliminate barriers that impair the efficient global allocation of resources, while helping some of the world’s poorest people. It’s an argument undermined by a simple thought experiment. Suppose we wiped the slate clean of the Trans-Pacific Partnership, the Transatlantic Trade and Investment Partnership, and other similar trade deals, and the world’s trade negotiators banged their heads to figure out the best way of achieving their stated goals. What would they be negotiating about?

January 26, 2017

Brad De Long has written a lengthy essay that defends NAFTA (and other trade deals) from the charge that they are responsible for the loss of manufacturing jobs in the U.S. I agree with much that he says – in particular with the points that the decline in manufacturing employment has been a long-term process that predates NAFTA and the China shock and that it is driven mainly by the secular trend of labor-saving technological progress. There is no way you can hold NAFTA responsible for employment de-industrialization in the U.S. or expect that a “better” deal with Mexico will bring those jobs back.

At the same time, the essay leaves me frustrated and uneasy. It seems to gloss over the distributional pain of NAFTA and overstate the overall gains.

So what does the evidence say on these issues? We have now some good academic papers that address both overall gains and distributional impacts.

Let’s start with the big picture. Remember first that many advocates of NAFTA made at the outset some wildly optimistic claims about what NAFTA was going to achieve. The most extravagant of the studies, and the one that probably was the most widely circulated, was one produced at the Peterson Institute for International Economics (then just the Institute for International Economics). This study argued that NAFTA would be a net job creator for the U.S., thanks to a projected improvement in the U.S. balance of trade. (This study is apparently no longer available on PIIE’s web site, but excerpts can be found here; see p. 58 for projected impacts.)

This argument was always a red herring: trade agreements are not supposed to create net employment; they simply reshuffle employment. NAFTA neither subtracted, nor added substantial number of jobs to the U.S. economy. At best, it made the U.S. economy more efficient by reallocating workers to jobs that are more productive.

And certainly this happened. But the overall efficiency gains are quite small, much smaller than what the trade volume effects would lead you to believe. A recently published academic study by Lorenzo Caliendo and Fernando Parro uses all the bells-and-whistles of modern trade theory to produce the estimate that these overall gains amount to a “welfare” gain of 0.08% for the U.S. That is, eight-hundredth of 1 percent! See their Table 2 (here or here). Trade volume impacts were much larger: a doubling of U.S. imports from Mexico.

What is equally interesting is that fully half of the miniscule 0.08% gain for US is not an efficiency gain, but actually a benefit due to terms-of-trade improvement. That is, Caliendo and Parro estimate that the world prices of what the U.S. imports fell relative to what it exports. These are not efficiency gains, but income transfers from other countries (here principally Mexico and Canada). These gains came at the expense of other countries.

A gain, no matter how small, is still a gain. What about the distributional impacts?

The most detailed empirical analysis of the labor-market effects of NAFTA is contained in a paper by John McLaren and Shushanik Hakobyan. They find that the aggregate effects were rather small (in line with other work), but that impacts on directly affected communities were quite severe. It is worth quoting John McLaren at length, from an interview:

Q. According to your study, what are the key impacts of NAFTA on U.S. wages?

For the average worker, there is not much of an impact, but for certain important pockets of workers, the lowered import barriers resulting from NAFTA do seem to have lowered wage growth well below what it would have been. This is particularly true for blue-collar workers. We did not see much of an effect on college-educated workers, and executives at the other end of the spectrum did gain some benefit from globalizing their production line.

There is also a big geographic component. Even if you do not work in an affected industry, if you work in a town that depends on one of those industries, your wage growth was likely affected. For example, a waitress working in a town that depends heavily on apparel manufacturing might miss out on wage growth even though she does not work in an industry directly affected by trade. To me, this was one of our most striking findings.

Q. Among impacted workers, how did wages change?

The most affected workers were high school dropouts working in industries that depended heavily on tariff protections in place prior to NAFTA. These workers saw wage growth drop by as much as 17 percentage points relative to wage growth in unaffected industries. If you are a blue-collar worker at the end of the ’90s and your wages are 17 percent lower than they could have been, that could be a disaster for your family. That was the largest impact we saw, and it is important to remember that the impact is much smaller for the average worker.

Q. Which industries have borne the brunt of the impact?

Industries that had a big tariff drop because of NAFTA, and that produce something Mexico tends to export, were hardest-hit in terms of wage growth. According to our data, this included many old-line manufacturing industries, such as those manufacturing apparel, textiles, footwear or structural clay products like brick and tile.

Q. Which geographic areas were most vulnerable?

We found the largest impacts in parts of Georgia, North Carolina, South Carolina and Indiana, with areas like Washington, D.C., Northern Virginia and Maryland among the least vulnerable locales.

In the discussion surrounding NAFTA, you often hear about impacts in manufacturing states like Ohio and Pennsylvania. We did not pick up too much impact there, likely because we were only looking at the effects of reductions in U.S. tariffs against Mexican goods. This study did not look at the effects of reducing Mexican tariffs on products from the U.S., which, paradoxically, could cause problems for U.S. workers as manufacturers move production chains south. That is something that we are researching currently and it could explain what we are seeing in areas like Ohio and Pennsylvania.

In other words, those high school dropouts who worked in industries protected by tariffs prior to NAFTA experienced reductions in wage growth by as much as 17 percentage points relative to wage growth in unaffected industries. I don’t think anyone can argue that a 17 percentage drop is small. As McLaren and Hakobyan emphasize, these losses were then propagated throughout the localities in which these workers lived.

So here is the overall picture that these academic studies paint for the U.S.: NAFTA produced large changes in trade volumes, tiny efficiency gains overall, and some very significant impacts on adversely affected communities.

The consequences of NAFTA for Mexico are another topic which would require a separate post. Let me just say that the great expectations the country’s policy makers had for NAFTA have not been fulfilled. Despite the country’s integration into North American production chains, overall productivity has stagnated. Mexico has been one of Latin America’s underperformers.

So is Trump deluded on NAFTA’s overall impact on manufacturing jobs? Absolutely, yes.

Was he able to capitalize on the very real losses that this and other trade agreements produced in certain parts of the country in a way that Democrats were unable to? Again, yes.

January 23, 2017

The last two decades have been a rare period of rapid convergence for the world's developing economies. Everyone is familiar with China and India's experience, but growth went beyond these two large economies. Many countries in Sub-Saharan Africa and Latin America had their best performance in decades, if not ever.

In a new paper, my co-authors Xinshen Diao (IFPRI) and Margaret McMillan (Tufts and IFPRI) and I examine this experience. We ask what drove this growth and how sustainable is it. Looking at recent growth through the lens of structural change proves particularly insightful.

Here is our decomposition of recent growth accelerations into the within-sector and between-sector terms. The latter term captures the growth contribution of structural change -- the reallocation of labor across sectors with different labor productivities.

What stands out in the analysis is that recent growth accelerations were based on either rapid within-sector labor productivity growth (Latin America) or growth-increasing structural change (Africa), but rarely both at the same time. In Latin America, within-sector labor productivity growth has been impressive, but growth-promoting structural change has been very weak. In fact, structural change has made a negative contribution to overall growth excluding agriculture, meaning labor has moved from high-productivity sectors to low-productivity activities. In Africa, the situation is the mirror image of the Latin American case. Growth-promoting structural change has been significant, especially in Ethiopia, Malawi, Senegal, and Tanzania. But this has been accompanied in these countries by negative labor productivity growth within non-agricultural sectors.

This is not how growth is supposed to happen. As we show in the paper, the East Asian pattern of growth was very different, with both terms contributing strongly to overall growth in high-growth periods. We develop a simple two-sector general equilibrium model in the paper to shed light on these patterns, especially the contrast between the African and Asian models.

We show that the Asian pattern of strong “within” and “between” components is consistent with growth being driven mainly by positive productivity shocks to the modern sectors. The African model, by contrast, is consistent with growth being driven not by the modern sector, but by positive aggregate demand shocks (due to foreign transfers, for example) or by productivity growth in the traditional sector (agriculture). In this version of the model, the modern sector expands and growth-promoting structural change takes place as increased demand spills over to the modern sector. (Our assumptions on preferences ensure that demand shifts are sufficiently biased towards the modern sector to ensure the modern sector expands in both cases, despite relative-price adjustments.) But labor productivity in the modern sector is driven down as a by-product, as diminishing returns to capital set in and less productive firms are drawn in. This is also consistent with the relatively poor performance of manufacturing in Africa.

January 22, 2017

The question in the title is perhaps the most important question we confront, and will continue to confront in the years ahead. I discuss my take in this paper.

Many economists tend to be global-egalitarians and believe borders have little significance in evaluations of justice and equity. From this perspective, policies must focus on enhancing income opportunities for the global poor. Political systems, however, are organized around nation states, and create a bias towards domestic-egalitarianism.

How significant is the tension between these two perspectives? Consider the China "trade shock." Expanding trade with China has aggravated inequality in the United States, while ameliorating global inequality. This is the consequence of the fact that the bulk of global inequality is accounted for by income differences across countries rather than within countries.

But the China shock is receding and other low-income countries are unlikely to replicate China’s export-oriented industrialization experience. So perhaps the tension is going away?

Not so fast. The tension is even greater somewhere else: Relaxing restrictions on cross-border labor mobility would have an even stronger positive effect on global inequality, at the cost of adverse effects at the lower end of labor markets in rich economies. On the other hand, international labor mobility has some advantages compared to further liberalizing international trade in goods.